One of the first decisions you’ll have to make once you decide to form a private company is whether to create a Limited Liability Corporation (LLC) or C-Corp, a corporation that is taxed separately from its owners. If you search the web for how to incorporate as a new company, you’ll get lots of information that says something like, “seek expert advice from business professionals when considering the pros and cons of various business entities” which —although good advice—doesn’t necessarily help much because you don’t have a sense of what your future holds.
In my opinion (and take it for what it’s worth) there is never a good reason to start as a LLC if you are in a medical device field. All the advantages are moot:
profits and losses can be passed through to owners without taxation of the business itself (there won’t be any profits before you need large amounts of investment and investors will only invest in C-Corps).
owners are shielded from personal liability (this is true of C-Corps too).
record-keeping is minimal: (if you don’t like record-keeping, medical devices is not your field! Everything is record-keeping in your engineering, your quality system, your clinical trials etc. Keeping financial records and organizational structures will be easy compared to all of that. In a separate post, I’ll link to some prototype documents you can use to meet the legal requirements of the C-Corp and you’ll see they are not too onerous).
If you start as a LLC (as my company did), you will have an awful time converting to a C-Corp when you want to take larger investments from private investors. It took us over a year to get everything straightened out, and LOTS of legal money. Some of the things from the LLC structure are still in effect and could not be converted. For example, LLCs cannot offer stock options to employees. They have something called Stock Appreciation Rights (SARs) for employees. In addition to being hard to explain to employees, SARs require you to give the company a valuation (and how on earth do you do that with a startup medical device company with no sales or regulatory clearance?). When we converted to a C-Corp, we could not legally convert the SARs of our early employees to stock options in the C-Corp. So, a legal nightmare.
And the last nightmare is filing IRS form 1065 for each of the partners. Every year the partners would not get the LLC tax records until April 15 and had to file extensions of their personal taxes because of it. It was not worth it and I learned that if I ever start a medical device company again, it will be a C-Corp from the start!
If you decide to go C-Corp, what state should you make your C-Corp? The canonical state is Delaware. Why? One major incentive to incorporate in the state of Delaware is that it offers favorable tax treatment for companies headquartered in other states. Some Delaware incorporation advantages include:
The nation's most advanced and flexible business entity laws
Low franchise tax for small businesses
Members, shareholders, officers, managers or directors of a corporation are not required to reside in Delaware
Non-residents do not pay personal income tax in Delaware.
No Delaware sales tax
So, the Delaware C-Corp is something of an industry standard that investors are very comfortable with. But it doesn’t necessarily outweigh other considerations. For example, in PA, our lawyers were comfortable making us a Pennsylvania C-Corp because there were potential tax advantages that were not available to Delaware C-Corps. So, listen to your lawyers if they say it might be better to be a [your state here] C-Corp.